Did Candyking close the IPO window?

3/5/2014 9:13:09 AM

Did Candyking close the IPO window?

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After several years of near total IPO drought, it looked like Platzer, Sanitec and Candyking would be a foretaste of a rushing spring flood. The withdrawal of Candyking’s December 2013 listing is a fitting occasion for a more accurate analysis of why IPOs have had such a hard time competing with private sales. The deciding factor is what is best for the buyer and seller at the actual time of sale. IPO or structured sale?

Unfortunately, the stock exchange comes off badly here. So even though we are likely to see several IPOs in 2014, we should remain aware that structural difficulties lie ahead. 

It is often claimed that the reason behind the IPO drought is that life as a listed company is a tough haul compared with the idyllic existence of a privately owned company. The debate has rolled along this well-worn path for nearly ten years. Opinions often diverge as to whether the exchange needs more, less or better regulation. Another familiar tune is that the stock market has an attitude problem, singing the praises of IPOs as an idea but then tightening the purse strings when companies actually dare to take the plunge. Negative journalists or risk-averse institutions normally also come in for their share when the IPO drought needs to be explained.

There are grains of relevance in these discussions, but they don’t go very far in terms of understanding the IPO drought. Understanding it calls for a thorough analysis of how buyers and sellers act at the actual time of sale.

When a midsize or large company is on the brink of being sold there are, in simplified terms, two paths for the owners to choose between. An IPO or a process (also called a structured sale) in which professional investors and industrial companies are provided basically full insight into the company to be sold. In return, it is expected that interested parties will bid on the company in a silent auction procedure. Structured sales were wildly popular during the past ten years, at the expense of the stock exchange. The IPO drought is not a result of fewer companies changing owners, but rather of the fact that these changes of ownership have become everyday occurrences.

The share of structured sales increased partly because the private equity sector has exploded in size and partly because this is a vastly superior method from the seller’s perspective.

Note that this argument has nothing to do with how well the stock exchange functions for companies that are already listed, as compared to private companies. The argument is only about the actual time of transaction, not about the pros and cons of different forms of ownership per se.

Following are a few of the many reasons that an IPO is at a disadvantage:

  • The buyer receives more information in a structured sale. In an IPO, prospective buyers are offered a prospectus and perhaps a lunch presentation by the CEO as decision data. In a process, prospective buyers are given much more information – accountants, lawyers and business experts go over all important documents, contracts and business relationships with a fine-tooth comb. Other consultants may visit the company and do in-depth studies of the competitive environment, risks and prospects. For reasonably well-run companies, it is undisputable that the buyers’ thorough scrutiny of the business results in a higher price. This is because the risk level is lower when no stones are left unturned and all nooks and crannies have been examined. The lower the risk, the higher the price. This truism also leads to the widespread suspicion that companies that actually elect to do an IPO are often those unable to withstand the scrutiny of a structured sale. An even clearer comparison is the housing market: a house that’s sold as-is without allowing buyers to poke around in every room will command a lower price than if it undergoes and passes a thorough inspection. 
  • The number of IPOs is also curbed by the advising industry, which often counsels against an IPO or at least emphasises the risks involved. Advisors are familiar with processes and, although investment banks can earn more from a successful IPO, advisors’ fees as a whole are normally higher in a structured process – since all interested parties often have their own advisors (e.g., lawyers, accountants, strategic and financial consultants). 
  • The psychological aspects of an auction drive up the price. After hundreds of hours of work on the part of the above-mentioned advisory teams, the interested parties have already “invested” a lot of time, energy, money and prestige in the deal. It’s often perceived as a major setback to have done all that work in vain. This is reinforced by the terminology: the goal is to be “a winner” (i.e., pay the most), while those who exhibit greater restraint “lose” the bidding. This sets bidders up to stretch themselves a bit further than may be healthy. 
  • The terms of the deal can be customised. In an IPO, shares are sold to institutions and the public – end of story. In a structured sale, the purchase price can be adjusted and the terms qualified in an entirely different way. This also provides an opening for greater willingness to pay and thus a higher price for the seller. 
  • The seller can make an exit directly. In an IPO, the principal owner who’s doing the selling is normally expected to retain a significant shareholding even after the listing. The seller then needs to maintain responsibility as principal owner, with all that this entails in terms of work effort and limited options for divesting the remaining shares. Not infrequently, this situation can last for years – to the benefit of no one. And a strange situation arises when the seller attracts criticism the moment the share price fluctuates sharply. If the share price goes up, the seller didn’t maximise the sales proceeds. If the share price drops, the seller is roundly criticised for being short-sighted or greedy or – even worse – for having duped the market with an asset that has hidden defects. 
  • It’s almost always a bad thing for the seller to set the sales price in advance, as is done via an issue price in an IPO. The issue price (or interval) is merely a “best guess” of the market’s willingness to pay. When an IPO issue price is set, it is often a price that can withstand fairly critical scrutiny even from investors who never subscribe for shares. The alternative (i.e., a price that large portions of the investor community perceive as unreasonable) results in a negative information buzz to the effect that the IPO candidate is being sold at way too high a price. This is what happened to Dometic a few years back. There was a very negative discussion in Sweden and, even though the IPO offer as a whole was fully subscribed, seller EQT withdrew the IPO and Dometic was later sold at an even higher price to another private equity company. We recently saw this pattern repeated with Candyking. In spite of constantly high levels of investor interest, the profit warning led to massive criticism. Even if there actually are categories of investors willing to pay the asking price, information buzz about the “overpriced company” can become self-fulfilling. And setting the issue price in advance swings both ways – the seller is forced in advance to waive the chance that a buyer might turn up who is willing to pay much more than initially assumed. 
  • The secrecy surrounding a structured sale makes it harder for buyers to understand the pricing. An IPO is marketed to asset managers and to a certain degree to private investors. Managers, analysts and institutional folks meet regularly and usually speak openly about what they think about the subject of the day – such as a current IPO. Private investors are exposed to these same views via the business media and, notwithstanding the investment banks’ constant assurances that “we have a major interest”, it’s usually fairly easy to obtain a more nuanced picture of how coveted an IPO candidate is and the approximate price level that’s deemed reasonable. Pricing thus tends to gravitate towards some kind of consensus. This is in sharp contrast to the secretiveness surrounding a structured sale, where bidders don’t know each other and know even less about what their opponents are thinking in terms of price and valuation. It’s relatively easy for the seller’s advisor to bid up the price by playing anonymous bidders against each other. The typical investor’s willingness to pay is therefore irrelevant. The only thing that matters is how much you can force up the price from the two most aggressive bidders. 
  • Off-exchange transactions often provide more leeway for clever approaches to, e.g., interest deductions for tax avoidance purposes or internal pricing. The aim here is not tax evasion or any violation of laws or regulations, but rather the experience of having more freedom to fiscally and otherwise optimise a business when a company is privately owned. 
  • The seller’s agenda will continue to be decisive in terms of choosing between an IPO and a structured sale. With a private equity and advisory industry that’s grown more muscle over the past decade, it is unlikely that IPOs will predominate over structured sales. In other words, the stock exchange is no longer the only taker. Realistic expectations are that the number of IPOs will stabilise at around a handful in good years and will be close to nil in bad years.

All of the above points weigh heavily in favour is a seller choosing a structured sale over an IPO. This has nothing to do with stock exchange regulations or quarterly capitalism – and all of the seminars, inquiries, analyses and debate articles that focus on this are wide of the mark. This also applies to Nasdaq OMX’s relatively new package of measures to improve life for listed companies.

The IPO drought is better explained by the inherent logic surrounding the transaction than by there being something seriously wrong with the regulations or with investors’ attitudes.
2014 will most likely be a good year from an IPO perspective, despite the Candyking profit warning blunder. But, regrettably, this does not herald the dawn of a new golden age, but is rather a sporadic spike in the long-term structural decline of IPOs relative to structured sales.


Peter Benson
Senior Consultant